Tuesday, March 20, 2012

The inflationary and non-inflationary effects of Job Guarantee in the public and private sectors.

Job Guarantee (JG) is the name given by advocates of Modern Monetary Theory to what might be called “make work” schemes – though obviously the phrase “make work” is a bit negative. I.e. JG is similar to the WPA implemented in the US in the 1930s.

One common claim by JG advocates is that any number of JG jobs can be created with no inflationary effects. And the reason seems to be (though this is normally not explicitly stated) that no extra demand is required to create JG jobs since the output of those jobs is given away rather than sold. I.e. public sector jobs do not require extra demand. Now there are problems with that argument, as follows.

First, there has been an ASTRONOMIC rise in public sector activity in advanced economies over the last century or so. Yet unemployment has not declined (in as far as measurements of unemployment a century ago are comparable to those currently used).

Second, and in contrast to the above EVIDENCE, there is the THEORY, which is as follows.

If the only input on JG schemes is labour that would otherwise be unemployed, then it’s true that there is zero inflationary impact (assuming the pay on such schemes is not too generous). However, any form of economic activity that involves anything like normal levels of output has to employ permanent skilled labour, capital equipment and materials – i.e. other factors of production (OFP). So JG schemes require OFP. But OFP does not appear from thin air: it can only come from the existing or regular economy. And that is inflationary for the following reasons.

As regards permanent skilled labour, withdrawing such labour from the regular economy is a reduction in aggregate supply. So aggregate demand has to be reduced if the inflationary effect is to be avoided. To that extent, JG jobs are AT THE EXPENSE OF normal or regular jobs: hardly the object of the exercise.

As to capital equipment and materials, ordering those up from the existing or regular economy is inflationary, assuming the economy is already at capacity. (If it’s not at capacity, then JG is not the best cure for unemployment: the best cure is a straight rise in demand. Indeed, I’ll continue with this “at capacity” or “at NAIRU” assumption in the paragraphs below.)

So the reason that the vast expansion in “give away” economic activity has had no effect on unemployment over the last century is that when well-paid jobs are created in the give-away sector, such labour virtually gives up looking for work in the private sector. That’s inflationary, so demand has to be reduced . . . You get the picture.

The OFP conundrum.

Output can always be improved on a JG scheme if the OFP to unskilled labour ratio is improved. But the more it is improved, the nearer the scheme becomes to amounting to the same as a normal public sector employer.

In fact, suppose there are two public sector outfits producing a similar product, a normal employer and a JG scheme, with the JG scheme employing significantly less OFT per unskilled person, where is the logic in that arrangement? The two outfits might as well be merged and be classified as a normal employer.

Is commercial JG inflationary?

As distinct from JG schemes where the output is GIVEN AWAY, there is no reason in principle why output cannot be SOLD. Indeed the output of the scheme set up in Hanstholm in Denmark thirty years ago was sold. See second article here.

If JG schemes are set up which SELL their output, obviously an increase in demand is required. And it might seem that that increase in demand is inflationary.

However, there will be no inflationary effect if the only input on the scheme is labour that would otherwise have been unemployed, AND IF the extra demand is actually channelled to such labour, rather than raising demand for relatively skilled labour. (That is because inflation stems from SKILLED labour shortages plus capital equipment and material shortages.)

Thus so far as inflation goes, there is no difference between a commercial and non-commercial JG scheme where both schemes employ only those who would otherwise have been unemployed.

But as soon as such schemes start employing OFP, the inflationary effect arises in both the case of commercial and non-commercial JG. So there again, there is little difference inflation-wise between commercial and non-commercial schemes.

Conclusion so far.

First, there is little point in making a distinction between JG schemes and normal or regular employers. That is, the relevant labour might as well be allocated to EXISTING employers.

Second, there is little point in making a distinction between public and private sector employers.

Why don’t JG employees displace existing employees?

If a JG scheme is a “specially set up” scheme as distinct from allocating labour to EXISTING employers, the extra demand needed to get the scheme going COULD spill over into other areas of the economy and exacerbate inflation. However, that problem is easily enough dealt with (at least in principle) by pricing the relevant product low enough.

However, where labour is allocated to EXISTING employers, an explanation is needed as to why demand is actually channelled towards those extra employees, rather than spilling over and raising demand for NON-JG labour. The explanation is here.